BOI reduces interest rate by 0.5 percent

Move made in effort to reduce panic on the local markets and boost growth; markets react positively.

October 6, 2008 20:45
BOI reduces interest rate by 0.5 percent

bank of israel 248.88. (photo credit: Ariel Jerozolimski)


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The Bank of Israel cut its benchmark interest rate by half a percentage point to 3.75 percent on Tuesday, in an effort to reduce panic on the local markets and boost growth. "The decision to reduce the rate now was taken in light of the increased uncertainty in world financial markets and their impact on local financial markets," the central bank said in a statement outlining the move, which surprised analysts. "Since the worsening of the global financial crisis and the implications for the local market, the chances of a slowdown in the country's rate of economic growth in the near future have risen. The current reduction in the interest rate will act to strengthen the economy's ability to weather the challenges confronting it," the statement read. The bank added that the rate cut, which will take effect on Sunday, was possible because inflationary pressures were expected to fall significantly because of lower commodities prices and slower economic growth. "The central bank's step is a necessary step at the right time to calm fears in the market and help exporters at a time of an economic slowdown," Shlomo Maoz, chief economist at Excellence Nessuah Investment House, told The Jerusalem Post. "However, this is only the first of a number of interest rate cuts we will see over the coming months." The markets reacted positively to the decision. The Tel Aviv-25 Index rose 3.91% to close at 797.92, while the Tel Aviv 100 Index climbed 4.62% to 716.40. The Tel-Tech Index surged 6.78% to 169.98 and the Tel Aviv Real Estate Index soared by 19.06% to close at 258.77. The shekel depreciated to 3.53 against the dollar in late trading. In New York, however, the misery worsened on Wall Street Tuesday, with stocks piling on the losses late in the session and bringing the two-day decline in the Dow Jones industrials to more than 875 points amid escalating worries about credit markets and financial sector. The Dow lost more than 500 points and all the major indexes slid more than 5 percent. Stocks ended lower for the fifth straight session. According to preliminary calculations, the Dow fell 508.39, or 5.11 percent, to 9,447.11. The drop came a day after the blue chips fell below 10,000 for the first time in four years. The Dow skidded as much as 800 points on Monday before finishing with a loss of 370. Earlier in the day, the Bank of Israel started to soothe growing fears of an escalation of the global financial crisis, reiterating its stance that the local economy and banking system were stable, while for the first time reassuring investors that it would employ monetary policy measures and help depositors if necessary. "The Israeli economy is in a good and stable situation. The growth rate is relatively high, there is a balance-of-payments surplus, the government debt-to-GDP ratio is falling, and the foreign currency reserves are high and increasing," the central bank said. "The banking sector in Israel is stable, but the central bank is ready to assist the banks with all means available with the aim of supporting depositors as necessary. No such assistance, however, is necessary at this time." The official statement on the economic and financial situation was issued as reports in the Hebrew press on Tuesday morning alleged that the Bank of Israel and the Finance Ministry were preparing a secret emergency economic intervention plan in case the situation in the country's financial markets worsened. The reported plan includes injecting billions of shekels into banks and the financial markets to stabilize pension funds and increase liquidity. Finance Minister Ronnie Bar-On and Bank of Israel Governor Stanley Fischer were meeting on a daily basis and joint teams had been set up to formulate contingency plans, the central bank said. President Shimon Peres expressed confidence on Tuesday in the ability of the economy to cope with the challenges of the global financial turmoil, after discussing the economic situation with Fischer and Finance Ministry director-general Yarom Ariav. "The Israeli economy has shown in the past and also today shows that it has the flexibility necessary to turn a crisis situation into an opportunity," Peres said. "I acted to stabilize the economy during the inflation crisis of the 1980s, the government acted in the beginning of 2000 and in the same vein we will act today when necessary." Furthermore, the central bank said that in view of growing global economic uncertainty, it would consider continuing to buy foreign currency beyond its original plan. In March, the central bank began buying $25 million in foreign currency daily - upping it to $100m. daily in July - in an attempt to stop the shekel's sharp appreciation, which was hurting exporters. The purchases are part of the bank's plan to increase its foreign currency reserves to as much as $40 billion. They amounted to $36.1b. at the end of September. The Israel Export Institute welcomed the central bank's plans to continue to buy foreign currency and prop up reserves beyond the $40b. if necessary. "The decision is in line with our recommendations sent to the governor a month ago and signals level-headed and responsible policy behavior by the Bank of Israel," said David Artzi, chairman of the Israel Export Institute. Market analysts and economists support the central bank's assertion that the local banking system is sound and there is no need for intervention at this point. At the same time, Terence Klingman, head of research at Excellence Nessuah Investments, cautioned that the banking system was threatened indirectly by the failure of the Israeli corporate bond market. "Israeli banks are still in sound financial condition. We feel the likelihood of a bank crisis in Israel is still low and it is highly unlikely that the government will be forced to bail out any Israeli bank," Klingman wrote, in a new survey of Israeli banks. "Nevertheless, it would be foolhardy to dismiss the risks emanating from the domestic corporate bond market failure," said Klingman. "Now the major emerging risk for the Israeli banks is the inability of major corporations, (particularly in the real estate sector), to roll over maturing corporate debt."

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